May 27, 2026
Greetings and happy summer!
If you would have told me two months ago that at the end of May, the war with Iran had still not been settled, interest rates on the 10-year treasury would be at 4.50% (up from 4%) but the S&P 500 was trading at all-time highs, I may have been a little skeptical of your enthusiasm. But here we are. As I write this, the S&P 500 is trading at another fresh all-time high and up 9.6% on the year. Meanwhile, The U.S. Aggregate Bond index is roughly flat on the year, up .15%.
Why have stocks ignored geo-political unrest, high gas prices and stubborn inflation? U.S. corporate profit growth. Coming into the first quarter earnings season, S&P 500 earnings growth was expected to be up an impressive 13% year over year. With about 95% of the companies reporting, earnings growth is up a staggering 28% over last year. Over half of that growth driven by the Magnificent 7 stocks (U.S. Large Growth companies). Earnings estimates for the remainder of the year have also ratcheted higher as the A.I. investment boom continues, along with productivity and profit margin gains as a result of companies utilizing artificial intelligence. There seems to be a cohort in the financial media that continues to compare this market to the dot com bubble of 1999 that ended in a sharp selloff and recession in the following years. I have written about this before, but I don't think there is ANY comparison, based on actual earnings. According to data from FirstTrust, from 1997-1999, the stock market doubled while corporate profit growth averaged only about 8% per year. Since 2023, the stock market is up about 55% and corporate profits are up over 50%. The market gains have been tracking profit growth which is exactly what markets are supposed to do. With the exception of possibly a handful of semiconductor stocks, I don't think we are in "bubble territory" rather current valuations are warranted.
Despite the higher gas prices, the U.S. consumer appears to be spending and consumption remains somewhat strong. Recent data from AAA and Open Table (tracking real time travel and restaurant spending) confirm that discretionary spending has not taken much of a hit from higher energy costs. In fact, AAA estimates a record 45 million people were traveling over the holiday weekend. Bottom line, as the pinch from higher energy costs is real, the U.S. consumer continues to shrug it off and spend on travel and leisure. I am not saying this can continue indefinitely. The war with Iran needs to draw to a close sooner rather than later so energy prices can ease and give relief to consumers (which would also likely add further gains to the U.S. stock market). If oil and gas prices remain at these levels for the next several months, I can only assume we will see some negative economic outcomes and possible pullback in stocks and bonds.
So, what can we expect over the next few months? Summer is typically a seasonally boring time for U.S. stocks, averaging low, single digit gains. I assume the markets will chug along and digest this impressive rally off of the March lows. Other than a hopeful agreement with Iran and lower energy prices, the next catalyst to move stocks much higher from here would have to come in July when second quarter earnings announcements kickoff. The bond market and interest rates are likely to be range bound until we either get data that points to long term, higher inflation or employment numbers fall off a cliff. The new Fed Chairman, Kevin Warsh is unlikely to change the current policy of keeping rates steady, but I do feel he is more inclined to cut rates later in the year when/if energy prices decline. Keep in mind that we typically see higher volatility in stocks as the mid-term elections approach as traders wring their hands over the "uncertainty" relating to the makeup of congress. If we do in fact see a correction in stocks as a result, I will very likely be a buyer in all portfolios. There are three possible outcomes when it comes to the midterms. Nothing changes, congress is split, or the opposing party will gain control of both houses. Keep in mind that historically, the markets do best during gridlock. Nothing gets done. In other words, Congress can't do anything to mess things up! In this year's midterms, if the Republicans keep control (which is unlikely), nothing changes from what we have had the last year and half. If Congress splits (likely), we have gridlock. If the Democrats sweep, I can't imagine the President signing any bills that come across his desk. More gridlock. In any scenario, nothing from a legislative standpoint is likely to derail the boom in U.S. Corporate profits and I feel the markets will continue to build on the gains thus far.
I hope you enjoy the summer months and please let me know if you have any questions.
Regards,
Larry
